Why Oil Stocks Are Better Investment Than Crude Futures

Oil prices are at their highest level in 27 months and, by most accounts, the gains are likely to continue. But for long-term investors, putting your money on oil futures may not reward you even if oil prices continue to rise.

U.S. oil futures are trading over $92 a barrel at the New York Mercantile Exchange and Brent crude futures are just $4 shy of the $100 milestone. Many analysts have said the light, sweet crude contract will easily hit that triple-digit mark this quarter.

Cold weather forecasts for next week across much of the U.S. and Europe and positive U.S. manufacturing and construction spending data have something to do with today's oil price rise.

Yet equities probably play an even greater role as investors often pour money into the stock market at the start of the year. Even with U.K. markets closed, the money flowing into exchange traded funds is likely a big driver in today's gains.

What ETFs will give oil investors the biggest benefit in 2011?

Well, if you're a "buy-and-hold" investor or even a daytrader who likes to trade ETFs instead of futures, you'll probably be better off putting your money into a oil equities ETF rather than betting on oil futures ETF. You certainly were much better off is you did that last year.

The investor who bought the largest oil equity ETF [XLE 68.76 0.51 (+0.75%)] last January gained nearly 20% by the end of 2010, while the U.S. oil futures ETF [USO 39.05 0.05 (+0.13%)] lost ground.

"The USO did not even make enough (-.71 percent) to pay the commissions on his investment," says oil analyst Olivier Jakob of Petromatrix.

The XLE owes much to the strong gains of its top holdings, such as Schlumberger [SLB 83.65 0.15 (+0.18%)] and Conoco Phillips [COP 68.24 0.14 (+0.21%)], which both gained nearly 30 percent last year.

Even in today's trade the XLE's top two holdings—Exxon Mobil [XOM 74.55 1.43 (+1.96%)] and Chevron [CVX 91.94 0.69 (+0.76%)]—are outpacing the performance in the spot price of crude oil. (Exxon is up over 2 percent!)

The U.S. crude oil futures contract continues to be rolled into a contango (as the front month price is trading at a price that is less than in the coming months in 2011), and for that reason, Jakob says the USO ETF will continue to underperform oil equity ETFs in 2011.

His view: Stay long the XLE versus short the USO for an expected yearly return of at least 10 percent.

Perhaps we are in for a repeat performance. It certainly was a great trade in 2010!